Escaping the Great Depression - and Extending the Greater Depression

Here at Casey Research, our view of the Great Depression of the
1930s is a little different from that of most people. In our eyes,
Franklin Roosevelt wasn’t a hero, he was a villain. Nearly everything
he did served to extend and deepen the economic downturn.

With the exception of supporting the 21st Amendment for the repeal of
Prohibition, Roosevelt’s involvement in the economy was an unmitigated
disaster. But in popular memory, that failure is obscured by U.S.
success in WW2, over which Roosevelt presided.

Today, unfortunately, Obama and his minions are taking Roosevelt as a
model and are straining to repeat his mistakes. Because the distortions
in today’s economy are far greater than those in the 1920s and 1930s,
and since the public now relies upon government far more than it did in
those days, I don’t see any way around a more serious depression – the
Greater Depression. It’s been going on since 2008, will get much worse,
and has years left to run.

FDR himself was extraordinarily lucky. His performance looks successful
because when he entered office, both the economy and the stock market
were overdue for a cyclical recovery (nothing goes straight down
forever). He was elected when the depression had already been going on
for four years and the stock market had already fallen 90%. That
fortunate timing was partly a gift from Hoover, whose large-scale
interference in the economy had kept the depression going. (It’s odd
how people believe Hoover was the free-marketeer and Roosevelt was the
interventionist. Roosevelt really just continued and extended Hoover’s
policies, but with more enthusiasm and far better PR.)

Roosevelt had more good luck (for him) with the arrival of WW2; the
victories in Europe and the Pacific forever idealized every aspect of
his administration. In many ways, the cult of FDR resembles that of
Russia’s Joseph Stalin, who is still worshipped there as a demigod.

Although Obama seems bright enough, there’s little reason to believe
he’s a student of history and no reason to believe he’s a student of
economics. It’s more likely that he’s just a student of power politics,
so he’s inclined to follow the conventional wisdom, which is that a
combination of Roosevelt’s “bold action” in the New Deal plus World War
2 brought the country out of the Great Depression. What we hope to
show here is that those notions are nonsense.

The Last Depression

How, in fact, did America recover from the Great Depression? The stock
answer is: “World War 2.” But a closer look at the data reveals a
different answer.

Standard mythology claims that war production – beginning in 1939 –
ended our economic troubles. But the American economy didn’t truly
recover until two years after the fighting stopped in 1945. In point of
fact, the last depression ran from 1929 to 1947, about 18 years.

And it wasn’t a single terrible decline. As the chart above shows,
GDP growth was falling in 1930, recovered from 1932 to 1936, and then
began a second collapse in 1937, a down-leg due mostly to Roosevelt’s
policies.

Then, in 1939, industrial production began a tremendous expansion. The
unemployed were put to work either fighting or manufacturing armaments.
But neither activity contributed to the general standard of living.
And even if it had, the growth in production wasn’t and couldn’t have
been self-sustaining, since it was in fact a growth in the squandering
of resources.

The conventions for measuring GDP include government expenditures,
so GDP is a poor measure of underlying economic health. The government
might, for instance, hire 10 million people to dig ditches during the
day, 10 million more to fill them in at night, and 5 million bureaucrats
to monitor the work. That would pump up GDP and reduce unemployment,
but it wouldn’t increase society’s wealth. It would decrease it.

In any event, as soon as the government’s large wartime expenditures
started dropping in 1945, GDP resumed the shrinking that had begun in
1930.

The GDP growth of the war years was a prosperity mirage that
dissipated when government spending stopped, unlike the wealth-creating
expansion from 1932 to 1936 that had been fueled by private investment.
In 1936, GDP rose $10.5 billion while government spending rose just
$2.2 billion. In 1942, GDP rose $35.2 billion while government spending
rose $36.1 billion. The apparent growth during the war was all
government spending.

Roosevelt’s Second Act

What caused the recovery to collapse in 1936?

One element was Roosevelt’s attack on the rich. In 1935, he launched a
barrage of new taxes, including a corporate income tax of 15%, a
dividend tax, higher estate and gift taxes, and additional taxes on
those earning more than $50,000. The top rate on individual income
taxes rose to 79% in 1936, a large jump from 63% just the previous
year.

On top of this, Roosevelt’s rhetoric and actions turned increasingly
anti-business. Roosevelt began to strongly support organized labor –
which was nice for those who had union cards, but no help for those who
didn’t have the connections or skin color to get one, and great harm
for the economy as a whole. His support got results. In 1935, there
were only 3.8 million union members in the U.S. By 1941, there were
about 10 million, approximately a quarter of the workforce.

The 1936 elections gave the country de facto one-party rule –
76 Democrats in the Senate and 331 Democrats in the House of
Representatives. Each new piece of legislation berated and punished
business – such as the Wagner Act, the ever higher taxing Revenue Acts,
and Undistributed Profits Tax. With the government growing larger
while business lacked strong representation in the halls of power, it
is no wonder that private investment stalled.

Government Versus Private Investment

Government expenditure as a percentage of GDP drives the point home
even more. Throughout World War 2, the private market remained in the
dumps.

War spending added to the GDP numbers. And there was real progress
in areas like aviation, electronics, and atomic energy – albeit at a
gigantic cost. But none of this jump-started the private economy, which
focuses on the products and services people really want.

You don’t need a doctorate in economics to understand this chart.
The only major peak during the war marks the end of hostilities – and
FDR’s death. (We’ll get to that in a moment). Note that the 1932-1936
recovery was far more significant than the often-glorified war
economy.

Why didn’t FDR’s immense spending jolt the private market back to life?
Remember that a wartime economy comes with strings attached; it’s not
free money. Wartime regulations made operating any business almost
impossible. Nearly everything required government permission. Taxes
skyrocketed, leaving less capital for investment. Further, forget about
competing for resources with the war industry; even if you had a good
business idea, you wouldn’t be allowed to execute it.

An economy can’t prosper when markets are being overruled by
command-and-control rationing. During the war, companies found it easier
and more profitable to produce for government than to produce for
consumers. Even companies such as Eastman Kodak, the film and camera
company, began manufacturing rifle scopes and hand grenades for the
military. GM stopped making cars for civilians and made military
vehicles instead. Tires, gasoline, shoes, beef, sugar, coffee and much
else were rationed. The standard of living in the U.S. during the war
collapsed; conditions for consumers were much worse than in the ‘30s.
Remember that the best definition of a depression is: A period of time
when most people’s standard of living falls significantly.

Without productive private investment, recovery is impossible. Near the
end of the war, as government spending subsided, private investment
did return to the U.S. But that never happened in the USSR, China, or
Eastern Europe, which is why they never did recover. Lack of private
investment is why Britain remained something of a dump right up to the
election of Thatcher. Wartime spending didn’t help the recovery, it
slowed it.

During the war, a majority of businessmen – typically over 75% –
believed the U.S. would retain the fascist-style economic system that it
had grown into during the ‘30s and that it seemed to be cemented into
by the war. With that thought so widespread, the lack of private
investment is no surprise.

But with the closing of WWII, the fear of being locked into a
command-and-control economy began to ease – an unintended consequence of
FDR’s wiliness. FDR knew that the business world would cooperate in
wartime production only if business leaders were running the show. He
slowly began replacing New Dealers in his administration with the
businessmen who had been squashed by New Deal policies. The new
recruits worked behind the scenes in Washington to undo what the early
New Dealers had accomplished. Necessity had overcome ideology.

On top of that, the Democrats were losing their grip on Congress. By
1944, they had only 56 senators and 242 representatives. In 1946, the
Republicans regained both houses of Congress.

And FDR himself died, which left businessmen feeling a lot safer. The
long dark night of anti-business tirades and crusades had ended. The
Dow made a significant jump, and so did the daily volume on his death.

Sure, Truman was still around, but he didn’t have Roosevelt’s
dangerous popularity. As a result, private investment flooded the
post-war market, and a boom followed. Where did the capital to fuel the
post-war boom come from? In a way, it was an accident of wartime
policies.

During the war, the personal savings rate skyrocketed. There were
plenty of reasons for that. For one, quality durable goods exempt from
wartime rationing were difficult to find even if one wanted to buy them.
Second, a big war creates uncertainty. If you’re not sure whether a
husband or father will return alive, saving makes sense. The importance
of savings in the 1940s is a reason for pessimism about our prospects
today: unlike during WW2, today’s savings rate is still negligible. And
the artificially low interest rates the government has engineered
continue to discourage saving and to encourage consumption, debt, and
speculation.

When the war ended, the accumulated savings supported both investing
and consumer spending. It’s an experience that refutes the Keynesian
notion that consumer spending stimulates the economy and saving
suppresses it.

You can’t solve today’s problem of overconsumption and debt with more
overconsumption and debt. The conditions that pulled America out of the
Great Depression underscore that point. Once savings rates increased
and made capital available for the economy, private investment soared,
and shortly afterward, so did the rest of the economy.

Although history doesn’t repeat, this time it definitely rhymes. The
Obama administration is trying to replay all of Roosevelt’s moves, and
it’s making all of FDR’s mistakes in spades and more. The Obama bailouts
of public companies are a new twist – even FDR didn’t go that far. The
U.S. is already in a war economy. Will Obama ramp up the wars,
thinking that what’s been done so far isn’t enough?

The bottom line is that, based on everything we know about the Great
Depression, the Greater Depression, which is still in its early stages,
is going to be nasty indeed.

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[Learning from history is only one of the many ways the editors of The
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